IInterest Expenses are the interest that’s payable on any loans, lines of credit, etc. It’s one of the key expenses in the income statement. Interest is often a separate line item under the operating income
Real-world case VISA Inc. #V
1. #V EBIT for the quarter ended in December 2020 totals:
EBIT = Net Income + Taxes + Interest = $3,126 + $622 + $96 = $3.844
2. #V EBITDA for the quarter ended in December 2020 totals:
3. #V Interest Expenses for the quarter ended in December 2020 totals ($136)
(See Figure 1)
4. Option 1: Use of EBIT
#V Interest Coverage Ratio for the quarter ended in December 2020 totals:
EBIT / Interest Expenses = $3,844 / $136 = 28.26
Here’s the bottom line: Visa’s ICR for the quarter ended December 2020 was 28.26. This means that Visa can cover interest payments 28 times using earnings before interest and taxes. The higher the ratio, the more stable the company.
5. Option 2: Use of EBITDA
Interest Coverage Ratio #V for the quarter ended in December 2020 totals:
The bottom line is similar: Visa can cover interest payments 29 times using earnings before interest, taxes, depreciation and amortization.
6. Let’s compare the ICR of the financial services companies that have large market capitalization:
MasterCard Inc. #MA 21.48.
PayPal Holdings #PYlPL 16.40.
When comparing its ICR with MasterCard, its key competitor, over five years, we can see that Visa slightly increased its ICR and looked more stable, while MasterCard had a decreased ICR, which may be a signal of liquidity problems in the future.
1. If interest expenses are negative, while the operating income is positive, you should use the usual formula.
2. If interest expenses and operating income are negative, a company has no income to pay interest.
3. If interest expenses equal and long-term debt equal “0”, a company didn’t have any loans.
Let’s assume that a company’s EBITDA/Interest Coverage is 1.30. This figure can’t clearly confirm that a company can cover its interest payments. Since EBITDA doesn’t include depreciation and amortization costs, 1.30 figure won’t help you measure the final stability. The reason for it is that a company must spend a significant portion of its income on replacing fixed assets, etc
Let’s sum things up
This metric is a reliable tool designed for analyzing whether a company can cover interest expenses. It’s relevant to use ICR when you analyze a company over time, in a single industry and when coupled with other multiples..